RBNZ signals interest rate rise in 2014

Record low interest rates are set to end but the Reserve Bank has signalled that won't happen until next year.

The central bank left the Official Cash Rate (OCR) unchanged at its record low of 2.5% on Thursday, the level it has been since March 2011, due to a high dollar dampening inflation pressures.

Graeme Wheeler. Photo: RBNZ

The recovery has been picking up steam this year and it didn't surprise many economists when the central bank explicitly stated that the cost of borrowing is likely to rise sometime next year.

But it did catch out financial markets, with the New Zealand dollar jumping to a five-year high on Thursday against the Australian currency and wholesale interest rates also surged.

The kiwi was sitting at 87.34 Australian cents at 7pm on Thursday, its highest level against the Australian dollar since late 2008. Shorter-term interest rates rose about 10 basis points and 10-year rates jumped 13 points.

The Reserve Bank says the pace of future increases will depend on the booming housing market's impact on prices, and it remains to be seen what effect proposed restrictions on low deposit loans will have on limiting housing growth.

Reserve Bank Governor Graeme Wheeler said on Thursday the New Zealand economy is picking up and growth is becoming more widespread across sectors.

Consumption was increasing and reconstruction in Canterbury would be reinforced by a broader national recovery in construction activity, particularly in Auckland. Mr Wheeler said rapid house price inflation persists in Auckland and Canterbury.

"As previously noted, the Reserve Bank does not want to see financial or price stability compromised by housing demand getting too far ahead of the supply response," he said in a statement.

Mr Wheeler said the New Zealand dollar remained high and continued to restrict export earnings and encourage demand for imports. Inflation remained very low over the past year but was expected to trend upwards toward the middle of the bank's 1% to 3% target band as growth accelerated over the coming year.

While the central bank is developing tools other than interest rates to help limit housing market growth, Mr Wheeler explicitly stated the cost of borrowing is set to rise, though not this year.

He said the amount of increases needed will depend on how much the growing momentum in the housing and construction sectors spills over into inflation pressures.

Westpac chief economist Dominick Stephens said the wording of today's statement represented a material change in the Reserve Bank's stance, and any OCR cut was now off the agenda.

"The key sentence was that the removal of monetary stimulus will likely be needed in the future. That's code for OCR hikes from a low level but they have ruled out hiking this year," he said.

"So I think what they're saying is that the OCR now seems likely to go up in early 2014 rather than late 2014."

Financial markets are predicting increases will start from March 2014.